Investing

10 Reasons the Federal Reserve Cannot Panic on Interest Rate Hikes

Whether you are a consumer, a business owner, an investor or merely a saver, the next big thing for the markets that comes with serious economic risks is the impending interest rate hike cycle. A consensus is building that interest rate hikes might not be imminent, but most pundits and indications are calling for the rate hike cycle to begin in 2015. That being said, 24/7 Wall St. has laid out 10 different reasons why the Federal Reserve is unlikely to hike interest rates too far or too fast.

The same points are also aimed at offering consumers and investors a reason to not panic about the higher interest rates ahead. Still, it seems a very safe bet to think that higher rates are coming. After all, we cannot expect a zero-percent short-term rate environment to persist for another five to seven years.

24/7 Wall St. has gathered and reviewed all the recent U.S. and international trends in the financial markets and the monthly economic reports. While we do expect higher interest rates to come this year, via Janet Yellen rate hikes, there just seems to be an overwhelming number of data points that keep pointing toward the argument that the public just doesn’t have to worry about rates rising too fast nor that rates will be raised too high.

As a reminder, raising interest rates generally cools off a hot economy. This is far from a hot economy. Lifting rates too fast, or too high, would likely harm what has already been one of the weakest economic recoveries of modern times. It remains obvious that Yellen and Fed presidents want higher rates, but it would be illogical that they want to kill the economy. They have also admitted that they are data-dependent. As an unofficial safety net, something we will address here, the Federal Reserve also has an implied conflict of interest or a vested interest in not raising interest rates too high and too fast.

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Most of the issues addressed are U.S.-centric, but they almost all have international ramifications. Issues highlighted are gross domestic product (GDP), the dollar, that inherent conflict of interest, deflation versus inflation, fed funds futures, central bank targets in Europe and Japan, payrolls and employment issues, housing, consumer spending and retail, industrial production and capacity utilization.

There are many things that can of course derail interest rate expectations, in both ways. The stock market has hit new all-time highs. The rate-sensitive sectors like utilities, real estate investment trusts (REITS) and other dividend payers have seen their shares weaken. Some talk of dollar-euro parity still persists, and oil has backed off sharply from old highs, even if it has stabilized.

To keep this from being a dissertation, many broad issued had to be skimmed over. Tax rates ahead and the geopolitical climate matter. Credit spreads, particularly in the junk bond sector, remain a concern. The price of oil, industrial metals, food commodities, gold and other commodities have to be considered. The 30-year Treasury has seen its yield rise almost 50 basis points in the past month, but it is still barely 3.0% — and the 10-year Treasury yield is still close to 2.25% despite a rise of 40 basis points.

What if the global economy has really bottomed, and what if things become better than expected, versus what we are seeing today? If the perfect storm occurs, then interest rate hikes could easily go further than expected. The problem under that scenario of rates rising higher or too fast is that this could almost instantly trigger another serious slowdown or worse, which likely would generate another easing cycle and perhaps come with reinstated quantitative easing trends in the aftermath.

One key issue to consider here is what “too high and too fast” really means. Can fed funds be raised to 1.0%? Absolutely. Can that happen in two months or in two Federal Open Market Committee (FOMC) meetings? Not likely. Still, a 1.0% fed funds rate likely would be a welcomed event by us and many others — just do not expect that to happen overnight. Can fed funds be raised to 3.0%? That would not be welcomed any time soon, nor would it accomplish anything other than killing the effort of the past six or seven years.

These are the 10 reasons featured by 24/7 Wall St. that the Federal Reserve just cannot panic into rate hikes too fast and why they cannot raise interest rates too high. These were not tasked in any specific order. There are of course many more supporting issues, but, again, this is not meant to be a dissertation.

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SPECIAL NOTE: Please note that all images used as supporting material can be expanded by clicking on them. This view on fed funds rate hikes is based on the most recent trends and releases, but readers should not interpret this as a prediction of economic numbers for the summer, fall and into 2016. Again, interest rate hikes are almost certainly coming and long-dated bonds are trying to price that in.